Why is the Solvency Ratio of Term Life Insurers Important?

When you set out to buy a term insurance plan, there are a number of aspects that you need to bear in mind. While going through the policy papers or doing your research, there may be certain terms you come across and do not understand completely. Generally, one such term is the solvency ratio. Read on to find out all the solvency ratio and the role it plays in term insurance.

What is a Solvency Ratio?

When you purchase term life insurance, your insurance provider offers to pay a predefined sum to the nominee selected by you if an unfavourable occurrence takes place. Keeping in mind the average mortality rate, an insurance company can easily manage its expenses when paying out claims. Now, imagine a natural disaster situation like an earthquake, tsunami, flood, etc. The level of damage these could cause is enormous, leading to higher claim submissions. The capability of an insurance company to pay off the claim amount can be measured through the solvency ratio.

It is a ratio used to measure the cash inflow and outflow, and liabilities of a company. In the simplest terms, the solvency ratio enables you to determine if the insurance company has enough cash on hand to handle both its immediate and long-term responsibilities, including claim settlements. If the insurance company has a poor solvency ratio, it will struggle to manage its financial responsibilities and thus fail to settle claims. Contrary to that, an insurance company with a higher solvency ratio indicates a better position where they have sufficient funds to manage their day-to-day expenses and resolve disputes and other financial commitments.

How is the solvency ratio calculated?

The solvency ratio is calculated based on the solvency margin of the business. Here, the liabilities of the business are compared in terms of current assets. Given below is the formula to determine the solvency ratio. Technically, to determine the solvency ratio, a business’s operational income after taxes is divided by its existing debt obligations.

Solvency Ratio = (Net income + depreciation)/liabilities.

Why is the Solvency Ratio of Term Life Insurers Important?

To secure the future of your loved ones, you buy a term life insurance policy. To avail of the benefits, you pay a premium amount for a certain period, against which your insurance provider offers you a sum assured value in return. In the event of an unexpected death of yours, the entire sum assured will be paid to the nominees.

However, it is important to understand that an insurance provider may receive thousands of claims every day. To pay off these claims, they need money, and the company will have money only if it is financially stable with sufficient funds. This is where the solvency ratio plays an important role. It shows the overall performance of the company, whether they are weak or strong in terms of financial strength. A higher solvency ratio increases the potential of your claim settlement by paying the sum assured to your nominee in case you are no more.

IRDAI on the solvency ratio?

IRDAI considers the solvency ratio at the prime. Hence, it has been made mandatory for every insurance provider to maintain a minimum solvency ratio of 1.5 with a 150% solvency margin1. IRDAI closely monitors the solvency ratios of insurance companies across India. You can also check the following table1 for the same:

Conclusion

While Claim Settlement Ratio and Turn Around Time are important factors to consider when choosing an insurance company, you also need to be mindful of the Solvency Ratio. A term insurance plan is your way of securing your family’s future in your absence. Make sure you make a well-informed decision.

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